Black Friday and Beyond

The timing of the Department of Justice’s strike rocked an industry caught off-guard, though the sweeping shutdown may finally pave the way for open regulation.
1937 3rd June, 2011 Opinion
Black Friday and Beyond

The timing of the Department of Justice’s strike rocked an industry caught off-guard, though the sweeping shutdown may finally pave the way for open regulation.

The Background

On April 15, 2011, the United States Department of Justice seized and shutdown the domains of the country’s three largest poker networks—PokerStars, Full Tilt and Cereus—and unsealed charges of bank fraud and money laundering against 11 of their owners. Hundreds of millions in 76 bank accounts across 14 countries were seized and the DOJ, working with the District Attorney in New York, filed a civil suit for penalties of $3 billion.

The poker industry was rocked by the sweeping strike. PokerStars and Full Tilt stopped US deposits and play the following day; Absolute Poker and Ultimate Bet ended deposits but continue to take bets from Americans, despite agreeing with the DOJ on May 4 to call off the action. In the week after Black Friday, PokerStars and Full Tilt, who held nearly 60% of the international market, saw volume slip 25% and 35%, respectively, according to PokerScout. Absolute Poker and Ultimate Bet lost 65% of their traffic, despite allowing Americans to continue to play.

More bad news followed. On May 23, a federal grand jury in Baltimore, MD indicted two companies (ThrillX Systems and K23 Group Financial Services) and their owners for money laundering and operating illegal gambling businesses. Ten domains, including DoylesRoom and TruePoker, were seized. The indictments were the result of an undercover operation by the US Attorney of Maryland and the state’s Homeland Security and IRS divisions, who created a payment processing business (Linwood Payment Solutions) that handed $33 million in gambling transactions.

Five years after the Unlawful Internet Gaming Enforcement Act (UIGEA) was snuck into the SAFE Port Act in the waning hours of congressional session, the US government means business with these shutdowns. The DOJ has been building its case against The Big Three since 2006. It had plateaud until Daniel Tzvetkoff, an Australian entrepreneur and payment processor, provided vital evidence incriminating the sites as part of a plea bargain after his arrest in April 2010. (Rumours abound that Full Tilt handed Tzvetkoff to the Feds after he had stolen $100 million from them and PokerStars. The companies had sued Tzvetkoff in court before, though were unsuccessful).

Finally with an understanding of the payment processing networks of The Big Three—and the companies they set up and bribed to facilitate them—the DOJ had enough evidence to issue warrants and seize domains. Interestingly, the indictments were handed down four weeks before April 15, though only unsealed then. What happened in the month prior to spur the DOJ into action? On March 24, Wynn Resorts announced a partnership with PokerStars with the intention of operating an online site together. Less than a week later Fertitta Interactive (Station Casinos) revealed a similar deal with Full Tilt.  

“With the strike the DOJ may have wanted to make their claim that PokerStars and Full Tilt were criminal enterprises before American interests got further entangled with them,” says Mike, who requested we do not publish his full name, of QuantitativePoker.com.

Whatever the reason, the timing has caught the poker industry off-guard, with many thinking the status quo would remain unchanged forever. The government’s shutdown, however, may finally pave the way for open regulation. Until now efforts for federal legislation have all failed, while there has been slightly more success at the state level, where a provision in the UIGEA permits online gambling as long as it remains within state borders.

While several states have moved to ban online poker, even more are considering legalizing it. Less than a week before Black Friday, lawmakers in Washington D.C. legalized online poker in the nation’s capital. Earlier this year, the New Jersey legislature approved intrastate gambling online but Gov. Chris Christie vetoed the measure—protecting the interests of brick-and-mortar casinos in Atlantic City, where, like in Las Vegas, operators have belatedly warmed to online poker (and its profit potential).

With this strike, the DOJ is enforcing the UIGEA as it interprets the law, and is cracking down on the financial web (the “black hole”) created to circumvent it. PokerStars and Full Tilt have always argued that poker is predominantly a game of skill and is therefore not illegal under the bill. The DOJ maintains that all online gambling is illegal, despite no law explicitly saying that. However, there is more than just legislation and morals at stake here.

The Numbers

Make no mistake governments like a bit of gambling, even online, as long as they are controlling and taxing it. A notable example: state-sponsored lotteries, where ticket subscriptions are sold over the internet in 12 states. Pari-mutuel betting has also flourished. Revenues from horse betting online, which is regulated in Oregon and run through designated hubs in 37 states, have grown from $6.2 million in 2000 to $1.4 billion last year.

Interestingly the DOJ has declared that horse betting online is not legal, though has taken no action. That’s because the states are collecting taxes. Thanks to an amendment to the Interstate Horseracing Act in December 2000, horse betting online generates tax revenues just shy of $300 million a year for the 37 participating states.

The problem for the US government is that the online poker industry is dominated by offshore operators like PokerStars, based in the Island of Man, and Full Tilt, headquartered in Ireland. They have no way to regulate and tax it. Online gambling is no small business either. There are over 500 poker rooms and more than 2000 gambling websites on the internet.

Worldwide gambling revenues neared $30 billion in 2010, according to industry analysts H2 Gambling Capital. Americans spent $4 billion last year gambling online, and over $30 billion in the past seven years. And the US government is seeing none of it. Neither are America’s brick-and-mortar casinos in Las Vegas and Atlantic City. There’s intense anger that The Big Three have continued to operate and profit post-UIGEA, while others like Party Poker (now Bwin.Party Digital Entertainment) paid fines and bowed out.

With the two dominant industry leaders ousted from the US market, many analysts now expect the government to pass legislation legalizing online poker. Regulation is inevitable, and will be welcomed by players and politicians alike. There is too much money in play, and state and national budgets are crippled by deficits.

In a report assessing the economic impact of regulated gambling in the United States, H2 Gambling Capital estimates that legalizing online poker will create 10,000 high-tech jobs and generate $2 billion in tax revenues in a year. The Financial Services Committee, headed by Rep. Barney Frank from 2007 to 2011, said taxes on online gambling could yield more than $40 billion over 10 years. Poker alone could produce $20 billion in revenues over the next decade, according to Frank Fahrenkopf, Chief Executive of the American Gaming Association (AGA). 

The Legislation

Although they would never admit it, the government recognizes that the UIGEA was ineffective in preventing offshore operators from depositing and withdrawing for Americans (though it made it ten times more expensive to do so, by some estimates). The United States was not alone in UIGEA-style legislation. Norway barred all financial transactions relating to offshore gambling in December 2008. Months later, however, the government abandoned the effort after deposits and volume increased despite the law, which came into effect on June 1, 2010—the same date for the UIGEA.

In both cases, particularly in the United States, legislation had short-term effects in reducing traffic, but demand remained and operators eventually found ways to meet that demand. Americans will continue to gamble online regardless of whether they or their politicians think poker is legal. Considering this, the significant potential tax revenues, and the fact that moral concerns for online gambling are often hypocritical and exaggerated, the case for legislation is strong.

So how to legislate and regulate? With deficits and revenues in mind, the United States will not follow the example of the United Kingdom, whose gambling Act of 2005 (effective September 2007) does not require operators to obtain licenses and pay taxes in Britain. Most sites have chosen to operate and be headquartered offshore, taking away potential revenues. Britain’s iconic Ladbrokes and William Hill, for example, moved their online operations last year to Gibraltar to take advantage of lower taxes.

The United States will likely not allow offshore operators to obtain licences and, if so, not without the strictest and harshest of provisions. Politicians and the AGA argue that established operators abroad have an unfair advantage because of the greater liquidity a foreign player pool provides. The US government is not interested in free and fair trade here. It has made that clear by repeatedly ignoring the World Trade Organization (WTO), which has ruled more than once that America’s stance on offshore gambling violates international trade and tariff agreements.

Instead, brick-and-mortar casinos and other US-based companies will run online websites, using their brands to attract and transition players. This is the plan that Caesars Entertainment’s Chief Executive Gary Loveman has been promoting in the press since Black Friday. In a televised interview for CNN on May 18, Loveman said that legalisation could finally provide the catalyst for Caesars to go public. He asked the panel - “Should we seize the moment to legalise online poker, permit a safe and legitimate industry in the United States, and bring those jobs and revenues home?" Unequivocally, the answer is yes.

One mistake the United States should not make is go the way of individual state legislation. With a federal approach, you avoid the risk of a patchwork of states creating ambiguous and inconsistent regulation. Also, why restrict gamblers to pools of players within their own borders? The vast majority of states are too small to provide sufficient liquidity. Only California and Florida (possibly a few others) have the size needed for their own networks.

Because of the lack of liquidity and the risk of inconsistent regulatory concerns and standards, online poker needs to be legalized at the federal level. This will still allow lawmakers to offer states the opportunity to opt in or out of legislation, preserving their autonomous rights. To accomplish this, the UIGEA needs to be repealed or, at the very least, severely amended.

Transparent accounting will be one of the biggest benefits of legislation. Regulators will be able to monitor money laundering and ensure sites accurately account for deposits, withdrawals, rake and taxes. Like in other financial industries, online poker companies would be subject to strict oversight. They would be required to maintain financial ratios and guarantee the protection of player funds. Brick-and-mortar casinos currently face similar oversight.

Another benefit to legislation: the government will be able to reduce and control many of the moral and social concerns relating to online poker. With basic regulation, it can exclude underage gamblers, using the same identification and verification methods used by stores that sell liquor, tobacco and pornography over the internet. Further, most countries that have legalized online poker (nearly 90 now) have established ways for impulsive gamblers to control deposit limits and restrictions. Horseracing and lottery subscription websites in the US have set up similar protections.

It is also important to note that there is little merit to concerns that online gambling increases the rate of compulsive gambling. Studies in the United Kingdom and Sweden show little to no increase in excessive gambling despite greater access due to legislation. Moreover, compulsive gamblers make up 1% of the population in the United States, and even smaller percentages in other countries; it’s hardly the widespread endemic that fanatical anti-gambling groups portray to politicians and the public.

While the negative social and financial effects of gambling should not be ignored (you can lose money and ruin relationships), they are often exaggerated. Some opponents, particularly politicians, are also often hypocritical—bashing online poker but forgetting the alcohol, tobacco, pornography and lottery tickets sold in their local stores.

And while gamblers can and do lose money, this is not a reason to ban poker or games of chance. In a recent Motley Fool article, reporter Morgan Housel reasoned: “Many players—most—lose money. But this is true of nearly every aspect of money and business. Most small businesses fail. And while luck isn't completely absent in poker, you'll also find a degree of luck in almost any successful business.”

Hardest of all for the US government may be keeping out unlicensed operators if all are barred. Other countries have found it difficult. Despite having initial success, Sweden’s Svenska Spel began losing gamblers to offshore operators, particularly PokerStars. DOJ enforcement against payments processors has increased the cost of depositing and withdrawing. Rising processing costs (now 10% of revenues by some estimates) and further asset seizures should help deter unlicensed operators. However, it will not be an easy fight.

The Bottom Line

The question whether to legalise only poker or all online gambling has commanded some attention. Legalizing only online poker is most likely, at least at first. The game has been winning more support recently in the skill-versus-luck debate. After pouring through data from last year’s World Series of Poker, famed economist Steven Levitt (author of “Freakonomics”) published a paper on May 10 concluding that poker was a game of skill, and highlighted that elite players see results that exceed the returns of investments in the financial markets over the long term.

As a result, many think that as a skill-based game poker deserves to be treated differently than other forms of gambling. This may be the case. However, the government may want to take this opportunity to legalise and regulate all types of gambling. Similar financial and moral arguments apply. Further, if the US were to legalise only poker the only options online for American casino and sports bettors would be offshore operators.

In whatever form legislation is shaped, it is obvious that something needs to be done. The popularity of online gambling persists despite the government’s attempts to discourage it, and the DOJ’s shutdown has pushed the market into the hands of operators least reputable. Those gambling online today are at greatest risk. Legislation will provide consumer protection, in addition to creating jobs and generating much needed revenues. While Black Friday was the biggest attack on the poker industry to date, the time for legislation is now.

Other articles you might like

Comments